U.S. Expands Plan to Buy Banks’ Troubled Assets

Treasury Secretary Timothy F. Geithner and President Obama in an economic briefing Monday.Credit
Todd Heisler/The New York Times

WASHINGTON — The Obama administration’s new plan to liberate the nation’s banks from a toxic stew of bad home loans and mortgage-related securities is bigger and more generous to private investors than expected, but it also puts taxpayers at great risk.

Taken together, the three programs unveiled on Monday by the Treasury secretary, Timothy F. Geithner, could buy up to $2 trillion in real estate assets that have been weighing down banks, paralyzing credit markets and delaying the economic recovery.

Investors reacted ecstatically, with all of the major stock indexes soaring as soon as the markets opened. The Dow Jones industrial average ended the day up nearly 500 points, or 6.84 percent, to 7,775.86. The thundering response was the mirror opposite of the bitter disappointment by investors when the plan was first vaguely described on Feb. 10.

“For the first time in seven months, I can say they’ve done it right,” said T. Timothy Ryan Jr., president of the Securities Industry and Financial Markets Association.

Despite lingering worries that Congress would add new pay restrictions or make other changes in the rules, several major investment firms, including BlackRock and Pimco, said they would participate as buyers of bank assets. Banks, which would sell mortgage assets in auctions, were less enthusiastic, though no major bank publicly said it would not participate.

Administration officials outlined a three-part Public-Private Investment Program that offers private investors vast amounts of cheap, taxpayer-supported financing for every dollar they put up of their own money.

In essence, the Treasury and the Federal Reserve will be offering at least a tablespoon of financial sugar for every teaspoon of risk that investors agree to swallow.

“There is no doubt the government is taking a risk,” Mr. Geithner acknowledged at a briefing for reporters. “The question is how best to do it.”

Under one main component of the plan, the Federal Deposit Insurance Corporation would oversee a program in which banks offer bundles of whole mortgages for sale to investors. The F.D.I.C. would set up an auction for each bank portfolio, allowing a bank to sell the mortgages to the investor that offers the highest bid.

But the crucial incentive for investors — traditional fund managers, hedge funds, private equity funds, pension funds and possibly even banks — is that the government would lend as much as 85 percent of the purchase price for each portfolio of mortgages.

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President Obama met with economic advisers on Monday. Programs to help banks recover from bad loans and problem mortgages were unveiled.Credit
Todd Heisler/The New York Times

On top of that, the Treasury would invest one dollar of taxpayer money for every dollar of private equity capital to cover the remaining 15 percent of the portfolio’s purchase price.

The arrangement is similar to some of the distressed-asset sales arranged by the Resolution Trust Corporation, the federal agency that was responsible for cleaning up the savings-and-loan debacle of the early 1990s.

In addition to the F.D.I.C.’s program, the Treasury would help finance a series of public-private investment funds to buy up unwanted mortgage-backed securities, or pools of mortgages that have been packaged into bonds with a credit rating.

Those two programs alone could buy $500 billion to $1 trillion worth of troubled assets, according to Mr. Geithner. The Treasury would kick in $75 billion to $100 billion from the Troubled Asset Relief Program as equity.

But the Treasury could pump almost $1 trillion more into the toxic-asset effort through a program called the Term Asset-Backed Securities Loan Facility, or TALF, a joint venture with the Federal Reserve.

That program, which became operational last week, was originally created to help finance mostly new consumer loans and also some new business lending.

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But in a major expansion, Treasury and Fed officials said Monday that they will expand the program to finance the purchase of existing troubled mortgage-backed securities, including those backed by commercial real estate loans.

The biggest inducement in all the programs is the government’s willingness to provide “nonrecourse” loans to institutions that buy up the unwanted assets. A nonrecourse loan is secured only by the underlying home or building.

If the borrower defaults, the government would only be able to seize the real estate. If the mortgages or the securities generate bigger losses than expected, the government and not the private investors would have to absorb the brunt of those losses.

Some analysts and fund managers were surprised that the Treasury was offering to lend up to $6 for every $1 of investors own money. Several noted that those terms appeared more generous than what Merrill Lynch offered when it sold a portfolio of mortgage securities to Lone Star Funds last July. In that deal, Lone Star bought Merrill’s assets for only 22 cents on the dollar and Merrill loaned Lone Star only $3 for every $1 the investor put up.

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Senator Judd Gregg, Republican of New Hampshire, left, and Senator Mitch McConnell, the minority leader, talked before a news conference on Monday.Credit
Doug Mills/The New York Times

“This is a better deal than Lone Star got,” said Barry Ritholtz, chief executive of FusionIQ, an investment research firm.

It is too early to tell whether the inducements amount to a huge taxpayer giveaway or a shrewdly designed package that ultimately returns a profit to taxpayers and stimulates the financial system.

Taxpayers could profit from the interest paid by the public-private partnerships on the government loans — the interest rate has not yet been set — and if the troubled assets rise in value above the prices paid to acquire them.

In the short term, the big question is whether the inducements are enough to overcome both rising political anxiety among investors and reluctance by banks to sell mortgages.

Mr. Geithner on Monday said there are no restrictions on compensation on the participating investors. Still, investors are worried about incurring the wrath of Congress if they appear to reap big profits.

Last week, after the Treasury acknowledged that employees at American International Group were getting $165 million in bonuses, the House voted to impose a retroactive, 90 percent tax on those bonuses.

The other potential obstacle could be on the side of the sellers — the banks. Because banks would probably have to sell their mortgages at a substantial discount to their original value, they would also have to write down the value of the mortgages and book a loss in the process. In turn, that could force many banks to raise more capital.

Bill Gross, chairman of Pimco, said in a statement that the Treasury plan was a “win-win-win policy” and that his firm was “intrigued by the potential double-digit returns” that it offered.

Laurence D. Fink, BlackRock’s chairman and chief executive, said his firm would invest in a broad range of mortgages and related securities through the Treasury plan. BlackRock is also exploring ways to set up mutual funds that would allow individual investors to participate.

The combined impact of all the Treasury and Fed bailout programs, he added, could start to stabilize the economy sooner than many expect.

“I think right now there’s so much pessimism that no one is seeing anything beyond their nose,” Mr. Fink said. “With all the triage from all different activities from the government, you could say that by the latter part of this year, we could start seeing the economy start restabilizing itself.”

Graham Bowley and Michael J. de la Merced contributed reporting from New York.

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